v :  :  •.«;■■*  ■■'  ,     -.■,  . 


UNIVERSITY 

OF  CALIFORNIA 

LOS  ANGELES 


SCHOOL  OF  LAW 
LIBRARY 


TREASURY  DEPARTMENT 
UNITED  STATES  INTERNAL  REVENUE 


UJ.     Inhrul   w**u*    &o/>'c4. 


EXCESS  PROFITS  TAX 


PREPARED  BY  THE  BUREAU  OF 

INTERNAL  REVENUE  FOR  THE  INFORMATION 

AND  ASSISTANCE  OF  TAXPAYERS 


WASHINGTON 

GOVERNMENT  PRINTING  OFFICE 

1913 


s 

5b 
\9\Z 


To  the  Taxpayer: 

The  great  body  of  patriotic  taxpayers  are  anxious  to  pay  their 
taxes  and  thus  fulfill  their  whole  financial  duty  to  the  Government. 
This  department  is  equally  anxious  to  help  them  fulfill  that  duty 
without  prejudicing  their  own  interests  or  paying  a  larger  tax  than 
under  the  law  they  are  called  upon  to  pay.  To  attain  this  end,  co- 
operation along  the  following  lines  is  necessaiy : 

1.  File  your  return  promptly.  You  have  until  April  1  to  do 
this,  but  you  will  greatly  assist  the  Government  by  filing  your  re- 
turn now.  This  will  be  to  your  own  advantage,  for,  if  you  have 
any  problem  that  requires  special  attention,  the  sooner  your  return 
is  in  the  earlier  will  your  case  be  reached  and  decided. 

2.  Secure  from  your  collector  the  proper  return  form  and  read 
carefully  the  instructions  and  questions  printed  thereon.  Get  at 
the  same  time  a  copy  of  Regulations  No.  41  and  use  the  index.  When 
in  doubt  on  any  point,  consult  your  collector  or  revenue  agent,  or 
your  banker.  If  still  in  doubt,  answer  each  question  as  you  under- 
stand it  and  send  with  your  return  a  statement  of  the  questions 
about  which  you  are  uncertain.  A  decision  can  then  be  made  at 
Washington,  where  the  administrative  authorities  are  as  anxious  to 
protect  your  interests  as  to  obtain  the  revenue.  In  this  way  you 
will  be  protected  against  penalties. 

3.  If  you  can  not  determine  your  invested  capital,  or  if  for  any 
other  reason  you  believe  yourself  entitled  to  make  claim  for  assess- 
ment under  section  "210  (art.  52  of  the  regulations),  make  out  your 
return  as  best  you  can  from  the  information  at  hand  and  file  with 
it  a  full  explanation  of  the  facts,  showing  wherein  information  for 
making  out  a  complete  return  is  lacking,  or  why  you  think  you  are 
entitled  to  assessment  under  section  210. 

1.  Tf  you  are  able  to  compute  the  amount  of  your  excess-profits 
tax.  yon  may  pay  the  tax  at  the  time  you  file  your  return.  By  so 
doing  you  will  reduce  the  great  rush  in  the  payment  of  taxes 
in  June.  If  you  pay  the  tax  in  advance,  you  may  deduct  from  the 
amount  of  the  tax  due  a  sum  equal  to  3  per  cent  per  annum  calcu- 
lated from  the  date  of  payment  to  June  15,  191S.  Taxes  may  also 
lie  paid  in  installments,  provided  the  installments  do  not  extend 
beyond  June  15.     Your  collector  will  explain  how  this  may  be  done. 

Daniel  C.  Ror-ER,  Commissioner, 

40*J1  1    l.H  g 


Digitized  by  the  Internet  Archive 

in  2008  with  funding  from 

Microsoft  Corporation 


http://www.archive.org/details/excessprofitstaxOOunit 


EXCESS  PROFITS  TAX  PRIMER. 


GENERAL  FEATURES. 

TAX  APPLIES  TO  TRADE  OR  BUSINESS. 

In  the  case  of  a  corporation  or  partnership  the  law  expressly 
provides  (sec.  201)  that  all  its  income,  from  whatever  source  derived, 
shall  be  deemed  to  be  received  from  its  trade  or  business.  In  this  case 
( here  is  one  business  and  one  net  income. 

In  the  case  of  an  individual  the  excess-profits  tax  applies  only 
to  that  part  of  the  net  income  which  is  derived  from  the  taxpayer's 
trade,  business,  profession,  or  occupation,  even  though  the  taxpayer 
may  have  other  income  subject  to  the  ordinary  income  tax.  Unlike 
a  corporation  or  partnership,  an  individual  may  be  engaged  in  two 
businesses,  one  with  invested  capital,  one  with  no  invested  capital 
or  only  a  nominal  capital.  If  he  has  more  than  one  business  with 
invested  capital,  they  will  all  be  regarded  as  one;  and  if  he  has  more 
than  one  business  with  no  invested  capital,  they  will  be  regarded  as 
one  If  he  has  both  kinds  of  business,  he  will  be  regarded  as  having 
I  wo  businesses. 

IT  IS  AN  INCOME  TAX. 

It  is  an  income  tax  in  addition  to  the  regular  income  tax  of 
September  8.  191G,  as  amended,  and  the  war  income  tax  of  Octo- 
ber 3,  1917.  It  is  more  than  a  tax  on  "war  profits":  it  reaches  all 
income  in  excess  of  a  stipulated  normal  deduction.  The  tax  falls 
into  two  classes: 

(a)  An  8  per  cent  tax  imposed  by  section  209  upon  trades  or 
businesses  having  no  invested  capital  or  merely  a  nominal  capital. 
e.  g.,  doctors,  lawyers,  and  professional  or  salaried  persons  in  gen- 
eral. Domestic  corporations  under  this  section  are  allowed  a  specific 
deduction  of  $3,000;  domestic  partnerships  and  individual  citizens  or 
residents  a  specific  deduction  of  $0,000.  (See  article--  71  7!  of  Regu- 
lations, Xo.  41.) 

(b)  A  graduated  tax  with  rates  rising  from  20  to  60  per  cent  upon 
the  net  income  in  excess  of  a  deduction  equal  to  a  percentage  (vary- 
ing from  7  to  9  per  cent)  upon  invested  capital,  plus  $6,000  in  the 
case  of  an  individual  or  partnership  or  $3,000  in  the  case  of  a 
corporation.  Foreign  corporations  or  partnerships  and  nonresident 
aliens  are  not  entitled  to  the  specific  deductions  of  $3,000  or  $6,000. 
respectively. 

An  exceedingly  important  subdivision  under  class  (&)  consists  of 
those  cases  in  which  the  invested  capital— or  the  net  income  for  the 
prewar  period — can  not  be  satisfactorily  determined.  In  such  cases 
the  assessment  is  based  largely  upon  conditions  or  relations  existing 
among  representative  business  concerns  in  a  like  or  similar  trade  or 
business.  (See,  Sections  205  and  210  of  the  law  and  Articles  is.  24, 
and  52  of  Regulations  No.  41.) 


G  EXCESS  PROFITS   TAX   PRIMER. 

CLASSIFICATION  OF  TAXPAYERS. 

Ill  the  case  of  a  corporation  or  partnership  all  of  its  income 
■will  be  held  to  be  of  the  same  class  as  the  income  from  its  principal 
trade  or  business.  There  is  one  income  and  one  tax.  (Article  14  of 
Regulations  No.  41.) 

In  the  case  of  an  individual  there  may  be  income  subject  to  the 
,s  per  cent  rate  and  income  subject  to  the  graduated  rates,  in  which 
case  there  will  be  two  deductions  and  two  taxes — but  not  more  than 
two.     (See  Articles  35  and  30  of  Regulations  No.  41.) 

in  general,  the  taxpayer  can  not  decide  for  himself  whether  he  is 
subject  to  the  8  per  cent  tax  or  the  graduated  tax  but  must  fill  out  the 
ordinary  form  so  far  as  possible  in  order  that  the  department  may. 
decide  into  which  class  he  properly  falls.  Exception,  however,  is 
made  in  the  case  of  individuals  whose  income  consists  wholly  of 
salary  or  the  earnings  of  personal  service  and  who  employ  no  in- 
vested capital  in  their  trade  or  business.  In  such  cases  the  excess 
profits  tax  will  be  computed  from  the  data  on  the  income  tax  return 
Form  1040. 

INCOME   SUBJECT   TO   TAX— CORPORATIONS,   PARTNER- 
SHIPS, AND  INDIVIDUALS. 

1.  A  partnership  makes  $80,000,  one-fourth  of  which  is 
paid  to  a  special  or  silent  partner  who  takes  no  real  part  in 
the  conduct  of  the  business.  Is  the  partnership  taxable  with 
respect  to  the  $20,000  paid  to  the  silent  partner? 

Yes.  The  partnership  is  engaged  in  business  and  is  taxable  upon 
it-  entire  net  income.  However,  no  member  of  the  partnership  as 
an  individual  is  subject  to  excess-profits  tax  on  his  share  of  the 
partnership  profits.     (See  Article  41  of  Regulations  No.  41.) 

2.  A  corporation  has  been  making  income-tax  returns  on 
the  basis  of  a  iiscal  year  ending  June  30.  Net  income  for  the 
last  six  months  of  1916  was  $1,000,000.  The  losses  for  the 
first  six  months  of  1917  were  $400,000.  Is  there  any  taxable 
income  subject  to  excess-profits  tax  for  the  year  1917? 

Yes.  The  profits  for  the  full  fiscal  year  were  $000,000.  One-half 
of  the  fiscal  year  falling  in  the  calendar  year  1917,  the  corporation 
will  be  taxable  on  a  proportionate  amount.  The  corporation  should 
make  a  return  for  the  full  fiscal  year,  compute  the  tax  that  would 
ordinarily  be  due  for  an  entire  year,  and  then  take  a  proportionate 
part  (in  this  case  one-half)  as  the  tax  to  be  paid.  (See  Article  19 
of  Regulations  Xo.  41.) 

3.  Is  a  "  Massachusetts  trust  "  taxed  as  a  corporation  or 
partnership? 

As  a  corporation.  The  term  "corporation"  includes  joint-stock 
companies  or  associations,  no  matter  how  created  or  organized.  (See 
Article  •!  of  Regulations  No.  41.) 

4.  A.  B.,  an  attorney,  bought  a  house  and  lot  in  June,  1917, 
received  rent  from  it  until  October,  1917,  and  then  sold  it  at 
a  profit.    Does  he  pay  on  rentals  and  the  profit? 

An  attorney  whose  business  is  of  a  purely  personal-service  nature 
is  taxable   at   8  per  cent  under  section  209.     He  might  buy  real 


EXCESS   PEOFITS   TAX   PRIMER.  7 

estate  for  investment  and  later  sell  it  at  a  considerable  profit,  but 
this  being  an  isolated  transaction  and  not  a  business,  the  income  and 
profits  therefrom  would  not  be  subject  to  excess-profits  tax.  He 
would  be  entitled  to  one  deduction  of  $6,000. 

5.  A  lawyer  with  a  considerable  income  from  his  practice, 
receives  fees  as  director  in  two  banks  and  an  insurance  com- 
pany.    Are  such  fees  taxable? 

Regular  service  as  a  director  constitutes  an  occupation  or  busi- 
ness and  the  fees  therefrom,  along  with  the  regular  income  of  the 
lawyer  from  his  practice,  are  taxable  at  8  per  cent  under  section  209, 
with  one  deduction  of  $6,000. 

6.  A  landlord  renting  a  large  farm  on  shares,  which  re- 
quires considerable  attention,  employs  an  agent  to  look  after 
his  interest,  see  that  the  farm  buildings  are  kept  in  good 
repair,  collect  and  market  his  share  of  the  crops,  etc.  Is 
the  rental  taxable? 

Yes;  at  the  graduated  rates.  The  landlord  is  engaged  in  business 
with  respect  to  the  farm  and  the  fact  that  he  employs  an  agent  to 
look  after  his  business  doe^-  not  relieve  him  from  the  tax  nor  entitle 
him  to  the  8  per  cent  rate. 

7.  John  Smith  owns  and  operates  a  dry  goods  store.  He 
also  owns  and  operates  a  shoe  store.  Is  he  allowed  to  re- 
port these  businesses  separately  with  a  separate  deduction 
for  each? 

Xo:  the  rule  is  that  there  may  be  one  deduction  for  a  business  with 
no  invested  capital  or  merely  a  nominal  capital  (personal  service), 
and  another  deduction  for  an  unrelated  business  having  invested 
capital,  but  there  may  not  be  more  than  one  deduction  for  businesses 
taxed  under  -eel ion  -201.  or  for  businesses  taxed  under  section  209. 

8.  I  conduct  two  entirely  separate  businesses  both  em- 
ploying invested  capital.  Should  I  make  a  combined  re- 
turn for  the  two  businesses,  or  a  separate  return  for  each 
business? 

You  should  make  one  return  covering  the  two  businesses. 

9.  A  contractor  and  dealer  in  real  estate  also  lists  prop- 
erty owned  by  others  and  does  business  as  a  real  estate 
agent  or  broker.     How  is  he  taxed? 

These  activities  are  so  interrelated  as  to  constitute  one  business. 
If  (he  individual  employs  in  this  real  estate  business  a  considerable 
amount  <>f  capital  lie  i^  taxable  at  the  graduated  rates  under  sec- 
tion 20  i. 

10.  I  am  a  doctor  and  also  manage  and  direct  a  small 
factory  which  I  own.     How  am  I  taxed? 

You  will  pay  a  tax  of  8  per  cent  on  the  fees  from  your  medical 
practice  under  section  209,  and  a  graduated  tax  on  the  income  from 
your  factory,  ruder  section  209  you  will  get  a  deduction  of  $6,000; 
miller  section  201  a  specific  deduction  of  sr>.noo  plus  a  percentage  de- 
duction of  from  7  to  9  per  cent  on  the  capital  invested  in  the  factory. 


S  EXCESS   PROFITS   TAX   PRIMER. 

11.  A  school  teacher  buys  a  farm  upon  which  oil  is  dis- 
covered, and  sells  the  farm  at  a  large  profit.  Is  such  profit 
subject  to  excess-profits  tax? 

Not  unless  the  teacher  is  also  a  farmer  or  buys  and  sells  real  estate 
with  sufficient  frequency  to  make  the  latter  one  of  his  occupations. 
The  teacher  may  have  an  occupation  or  business  other  than  teaching 
the  profits  from  which  would  be  lax-able,  but  if  he  buys  a  farm  simply 
as  an  isolated  investment  and  does  not  run  it,  the  profits  from  its  sale 
would  not  be  subject  to  the  tax.     (See  question  12.) 

12.  A  manufacturer  who  has  been  in  business  for  many 
years  sells  his  factory  at  a  considerable  profit.  Is  such 
profit  subject  to  excess-profits  tax? 

Yes:  because  the  profit  in  this  and  similar  cases  is  a  normal  result 
of  winding  up  the  business;  it  is  part  of  the  business.  On  the  other 
hand,  if  the  manufacturer  had  bought  a  farm  and  sold  it  at  a  profit, 
the  profit  would  not— if  the  transaction  were  isolated — be  taxable. 
Profit  from  an  isolated  transaction  outside  of  his  business  is  not  tax- 
able. Profit  from  an  isolated  transaction  connected  with  his  busi- 
ness is  taxable. 

13.  I  am  a  traveling1  salesman,  working  wholly  on  a  com- 
mission basis.  I  earn  $15,000.  My  traveling  expenses 
are  $3,000.  My  house  advances  me  $6,000  per  year,  giv- 
ing me  the  rest  of  my  commissions  at  the  end  of  the  year. 
May  I  consider  that  I  am  in  business  and  allow  myself  a 
salary  of  $6,000,  leaving  a  profit  of  $6,000  for  the  business 
itself?  In  that  case  I  should  be  entitled  to  a  deduction  of 
$6,000  for  the  business  and  $6,000  against  my  salary  and 
I  should  have  no  excess-profits  tax  to  pay. 

No.  You  should  enter  the  $15,000  in  block  A  on  Form  1040, 
making  proper  deduction  for  expenses.  You  would  then  have  a 
net  income  of  $12,000,  of  which  $G,000  would  be  taxable  at  the  8 
per  cent  rate. 

14.  An  individual  who  received  a  salary  of  $8,000  during 
the  taxable  year  has  a  minor  son  who  earned  $800  during  the 
taxable  year  in  a  separate  occuption.  Must  the  $800  be  in- 
cluded in  the  income  of  the  parent  subject  to  excess-profits 
tax? 

Xo.  The  father  is  not  engaged  in  business  with  respect  to  the 
income  of  his  minor  children  earned  in  a  separate  and  distinct 
occupation. 

DEDUCTIONS. 

15.  A  corporation  had  a  net  income  of  $10,000  in  1911, 
$8,000  in  1912,  and  a  loss  of  $2,000  in  1913,  What  is  the 
"  average  amount  of  the  annual  net  income  of  the  trade  or 
business  during  the  prewar  period,"  for  the  purpose  of  de- 
termining the  percentage  deduction? 

Six  thousand  dollars  ($18,000  divided  by  three).  The  loss  of 
$2,000  is  disregarded  inasmuch  as  the  income  tax  law  does  not  per- 
mit the  loss  of  one  year  to  affect  or  reduce  the  profit  of  another  year. 


EXCESS  PROFITS   TAX   PRIMER.  9 

16.  A  firm  commenced  business  April  1,  1911.  What 
period  should  it  use  to  determine  its  prewar  earnings  and  in- 
vested capital? 

All  of  the  years  1912  and  1913.  The  year  1911  is  disregarded, 
as  the  law  provides  that  onlv  entire  calendar  years  shall  be  counted. 
(See  sec.  200.) 

17.  What  percentage  deduction  is  given  a  taxpayer  who 
started  in  business  after  January  1,  1913? 

Eight  per  cent  of  the  invested  capital.  (Sec  sec.  204  of  the  law 
and  art.  21  of  Regulations  Xo.  11.) 

18.  Jones  was  in  the  hardware  business  during  the  prewar 
period.  He  made  more  than  9  per  cent  on  his  invested 
capital.  In  1914  he  sold  the  hardware  business  and  estab- 
lished a  furniture  store  and  is  making  over  9  per  cent.  What 
percentage  deduction  does  he  get? 

Eight  per  cent,  since  he  is  now  carrying  on  a  business  in  which  he 
was  not  engaged  during  the  prewar  period.  However,  if  he  had 
bought  an  established  furniture  business  having  prewar  earnings  of 
9  per  cent,  he  would  be  allowed  9  per  cent,  the  business  being  a  con- 
tinuation of  a  business  with  prewar  experience.  (See  section  201  of 
the  law  and  article  22  of  Regulations  Xo.  11.) 

19.  Smith  bought  a  hotel  business  in  1914  which  had  been 
in  existence  during  the  prewar  period,  but  he  is  unable  to 
ascertain  what  was  its  average  invested  capital  for  that 
period.     What  is  his  percentage  deduction? 

He  should  compute  the  tax  in  the  first  instance  on  the  basis  of  a  7 
per  cent  deduction,  but  may  file  a  claim  (with  explanation)  for  final 
assessment  under  the  provisions  of  section  210  (articles  24  and  52 
of  regulations.  Xo.  11).  and  if  the  Secretary  of  the  Treasury  is 
unable  satisfactorily  to  determine  the  invested  capital,  the  per- 
centage deduction  will  be  computed  at  the  same  rate  per  cenl  as  in 
the  case  of  representative  individuals  engaged  in  a  like  or  similar 
business. 

20.  An  individual  is  engaged  in  the  manufacturing  busi- 
ness. He  makes  annual  contributions  to  a  near-by  hospital 
in  which  injured  employees  of  his  establishment  are  cared 
for.  He  also  makes  contributions  to  his  church  and  to  the 
public  library.  Is  he  allowed  to  deduct  these  contributions  in 
computing  his  net  income  for  purposes  of  the  excess-profits 
tax? 

The  contributions  to  the  hospital  would  constitute  a  proper  de- 
duction, since  they  have  a  reasonable  connection  with  his  business, 
and  may  be  considered  as  coming  from  the  business  rather  than  from 
the  individual  in  his  personal  capacity.  Such  contributions  will  be 
allowed  up  to  15  per  cent  of  the  income  of  the  bush 

The  contributions  to  the  church  and  the  library  will  be  regarded 
as  made  by  the  individual  in  his  personal  capacity  and  arc  not  allow- 
able deductions  from  the  income  of  the  trad  for  the 
purposes  of  the  excess-profits  tax.  (See  article  37  of  Regulations 
No.  11.) 


10  EXCESS    PROFITS    TAX    PRIMER. 

21.  A  partnership  has  been  in  the  habit  of  making  contribu- 
tions to  various  churches,  local  charities,  and  the  Y.  M.  C.  A., 
and  charging  the  amounts  off  to  profit  and  loss  at  the  end  of 
the  year.  Will  it  be  allowed  to  deduct  these  contributions  in 
computing  its  net  income  for  purposes  of  the  excess-profits 
tax? 

No.  These  contributions  are  not  connected  with  the  trade  or  busi- 
ness. The  same  rule  applies  in  the  case  of  a  partnership  as  in  the 
case  of  an  individual.  (Sec  sod  ion  206  of  the  law  and  article  37  of 
Regulations  No.  41.) 

22.  An  incorporated  department  store  occasionally  con- 
tributes to  local  charities,  hospitals,  etc.  Are  these  items 
deductible? 

No.  Donations  which  do  not  have  in  them  the  element  6f  compen- 
sation are  considered  gratuities  and  are  not  allowable  deductions 
from  gross  income  as  an  expense  of  operation  or  maintenance  or 
under  any  other  head.  (See  articles  134  and  135,  Regulations  No.  33 
(Revised),  governing  the  collection  of  the  income  tax.) 

23.  Several  of  our  regular  employees  have  enlisted  in  the 
service  of  the  United  States  in  different  capacities,  some  in 
the  Army,  others  in  the  Navy,  Food  Administration,  etc. 
We  have  continued  their  salaries  during  their  absence.  May 
we  charge  these  payments  as  expense  in  computing  our 
profits? 

Yes. 

24.  Four  other  attorneys  and  myself  conduct  a  law  busi- 
ness under  a  partnership  arrangement.  There  is  no  invested 
capital.  It  is  our  custom  to  distribute  the  entire  net  income 
to  the  partners  as  salaries,  leaving  the  partnership  no  net 
profits.  May  we  continue  to  do  this?  If  the  partnership 
makes  a  return  it  will  be  entitled  to  a  deduction  of  $6,000  and 
the  several  partners  are  each  entitled  to  the  same  deduction. 
In  other  words,  if  we  make  a  separate  return  for  the  partner- 
ship there  will  be  a  total  of  six  $6,000  deductions,  whereas  if 
all  the  net  income  is  distributed  and  taxed  to  the  individual 
partners  there  will  be  only  five  such  deductions.  In  the 
latter  case  the  Government  will  collect  $480  more  tax.  We 
prefer  not  to  a  make  a  partnership  return. 

The  department  will  not  recognize  a  division  or  sharing  of  the 
entire  net  income  of  a  partnership  as  an  allowable  method  of  deter- 
mining the  salaries  of  the  partners,  although  in  rare  cases  the  salaries 
may  exhaust  or  even  exceed  the  net  income  of  the  partnership.  (See 
article  3*2  of  Regulations  No.  41.)  Every  domestic  partnership  hav- 
ing a  net  income  of  $6,000  or  more  without  deducting  salaries  or 
interest  paid  to  partners  must  make  a  return  of  income  on  Form  1065. 

CONCERNS  IN  OPERATION  ONLY  PART  OF  TAXABLE 

YEAR. 

25.  A  partnership  was  established  and  began  operations 
August  1,  1917.  The  capital  invested  was  $300,000  and  the 
net  income  for  the  five  remaining  months  of  1917  was 
$60,000.    What  is  the  tax? 


EXCESS  PROFITS   TAX   PRIMER.  11 

As  the  net  income  covers  only  five-twelfths  of  a  year,  the  deduction 
and  the  invested  capital  must  be  brought  to  the  same  basis.  Five- 
twelfths  of  the  total  deduction  for  a  full  year  is  $12,500.  (The  per- 
centage deduction  for  a  full  year  would  be  $24,000  and  the  specific 
deduction  would  be  $6,000,  a 'total  of  $30,000.  Five-twelfths  of  the 
last  figure  is  $12,5(J0.)  Five-twelfths  of  the  total  invested  capital  is 
$125,000.  Thus  in  this  case  the  tax  would  be  computed  on  the  basis 
of  an  invested  capital  of  $125,000,  net  income  of  $00,000,  and  a 
total  deduction  of  $12,500.    The  tax  would  be  $20,750. 

26.  A  corporation  organized  July  1,  1917,  makes  $2,400  in 
the  last  half  of  that  year.  Is  it  required  to  make  return  and 
pay  excess-profits  tax? 

Yes.  A  corporation  engaged  in  business  for  only  a  part  of  the 
3'ear  must  make  return  if  its  net  income  is  at  the  rate  of  $3,000  or 
more  per  annum.  A  similar  rule  applies  to  an  individual  or  partner- 
ship engaged  in  business  for  only  part  of  the  taxable  j'ear :  a  return 
must  be  made  and  the  excess-profits  tax  paid  if  the  net  income  for 
the  taxable  year  is  at  the  rate  of  $6,000  or  more.  (This  answer  does 
not  apply  in  the  case  of  a  corporation  or  partnership  whose  first 
fiscal  year  ends  in  1918  and  which  has  secured  permission  to  make 
its  return  on  the  basis  of  its  fiscal  year.) 

INVESTED  CAPITAL. 

27.  Secton  207  (clause  3)  authorizes  the  inclusion  in  in- 
vested capital  of  "  paid  in  or  earned  surplus  and  undivided 
profits  used  or  employed  in  the  business."  Can  a  corporation 
or  partnership  have  any  surplus  or  undivided  profits  which 
for  purposes  of  the  excess-profits  tax  will  not  be  deemed  to 
be  used  or  employed  in  the  business? 

All  the  surplus  and  undivided  profits  of  a  corporation  or  partner- 
ship (exclusive  of  undivided  profits  earned  during  the  year)  will, 
unless  invested  in  assets  the  income  from  which  is  not  subject  to  the 
excess-profits  tax.  be  deemed  to  be  used  or  employed  in  the  business 
and  may  be  included  in  the  invested  capital.  (Sec  art.  G2  of  Regu- 
lations Xo.  41.) 

28.  A  corporation  balances  its  books  monthly,  carrying 
profits  into  surplus  account.  Is  the  capital  as  of  January  1st 
increased  for  the  purposes  of  the  excess-profits  tax  by  the 
addition  of  these  monthly  profits? 

\<>.  The  law  specifically  excludes  undivided  profits  earned  during 
the  taxable  year.  The  profits  accumulated  during  the  year,  even 
though  entered  on  the  books  as  surplus  before  the  close  of  the  year, 
can  not  be  counted  as  additions  to  the  capital  for  that  year.  (See 
art,  <;l  of  Regulations  Xo.  41.) 

29.  In  computing  invested  capital  for  the  purposes  of  the 
excess-profits  tax,  may  a  corporation  take  as  the  value  of  its 
capital  stock  the  amount  fixed  by  the  department  for  the  pur- 
poses of  the  capital-stock  tax? 

No.     Each  return  tnusi  be  prepared  in  accordance  with  the  pro 

vision-  of  the  law    under  which   i(    is  made. 

30.  According  to  section  207,  bonds  (other  than  obliga- 
tions of  the  United  States),  the  income  from  which  is  not 


12  EXCESS    PROFITS    TAX    PRIMER. 

subject  to  the  excess-profits  tax,  can  not  be  included  in  in- 
vested capital.  Section  200  states  that  ''  The  term  '  United 
States '  means  only  the  States,  the  Territories  of  Alaska  and 
Hawaii  and  the  District  of  Columbia.''  May  State  bonds  be 
included  in  invested  capital? 

No.  The  above  definition  applies  only  in  a  geographical  sense. 
The  Umiu  "United  States"  in  the  parenthetical  clause  above  is  not 
used  in  a  geographical  sense  Hence  (he  term  "obligations  of  the 
United  States"  means  only  obligations  of  the  Federal  Government. 

31.  In  1901  a  corporation  was  organized  and  took  over 
the  assets  of  a  dozen  going  concerns,  issuing  therefor 
$25,000,000  of  capital  stock.  The  assets  consisted  of  various 
plant  structures,  equipment,  real  estate,  patents,  and  good 
will.  At  the  time  of  the  transaction  all  of  these  items  were 
entered  in  a  lump  sum  and  no  attempt  was  made  to  indicate 
the  specific  amounts  of  stock  issued  for  the  respective  kinds 
of  property.  It  is  shown  that  at  that  time  the  tangible  prop- 
erty was  worth  $10,000,000,  the  patents  $2,000,000,  and  the 
good  will  not  less  than  $7,000,000.  How  is  the  invested 
capital  to  be  computed? 

In  accordance  with  article  59  of  Regulations  No.  41,  it  will  be  pre- 
sumed that  $12,000,000  of  the  stock  was  issued  for  the  tangible  prop- 
erly and  Ihe  patents  and  that  $13,000,000  was  issued  for  good  will. 
The  tangible  property  will  be  taken  at  its  value  as  of  January  1,  1014. 
but  not  to  exceed  $10,000,000,  the  par  value  of  the  stock  deemed  to 
have  been  issued  for  it.  The  patents  will  be  taken  at  their  value  at 
the  time  of  acquisition,  namely,  $2,000,000.  Although  $13,000,000  of 
stock  was  issued  for  the  good  will,  it  can  be  taken  at  only  $5,000,000. 
i.  e.,  20  per  cent  of  the  total  stock  outstanding  on  March  3,  1917. 

32.  A  banking  corporation  began  operations  in  1902.  In 
the  course  of  12  years,  for  reasons  of  conservatism,  the  bank 
charged  off  practically  the  entire  value  of  its  building,  and 
since  January  1,  1915,  has  been  carrying  it  on  its  books  at 
the  nominal  figure  of  $1.  Can  any  of  this  value  be  restored 
for  the  purpose  of  computing  invested  capital? 

Yes.  The  building  may  be  taken  at  cost,  less  a  fair  allowance  for 
depreciation.  However,  any  amounts  which  may  have  been  allowed 
as  a  deduction  for  depreciation  under  the  income-tax  law  can  not  be 
restored. 

33.  A  farmer  bought  a  piece  of  land  December  1,  1913.  He 
has  put  no  new  money  in  the  business,  but  has  spent  all  his 
income  from  the  land  for  tile  and  ditching.  The  farm  cost 
originally  $4,000,  and  is  now  easily  worth  $10,000.  In  com- 
puting invested  capital  should  the  value  as  of  January  1, 
1914,  be  taken? 

Xo.  The  property  will  be  valued  at  cost,  less  depreciation  (on 
buildings,  etc.),  plus  the  amount  of  earnings  from  year  to  year 
invested  in  the  permanent  improvement  of  the  property. 

34.  Article  18  of  the  regulations  says  that  when  the  de- 
duction is  determined  under  article  24  a  "  constructive  " 
capital  will  be  used  for  applying  the  rates  of  taxation.  It 
may  be  that  in  some  cases  it  will  be  impossible  to  determine 


EXCESS  PROFITS  TAX  PRIMER.  13 

satisfactorily  the  invested  capital  for  the  prewar  period,  but 
quite  possible  to  determine  the  invested  capital  for  the  tax- 
able year.  In  such  cases  the  deduction  will  be  determined 
under  article  24.  Will  the  constructive  capital  described  in 
article  18  be  used? 

Xo.  The  constructive  capital  is  to  be  used  only  in  cases  where  it 
is  impossible  to  determine  satisfactorily  the  invested  capital  for  the 
taxable  year. 

35.  In  1900  a  corporation  was  organized  and  took  over  a 
mining  property  then  valued  at  $1,000,000.  For  this  prop- 
erty the  corporation  issued  stock  to  the  amount  of  $1,000,- 
000.  As  a  result  of  development,  the  discovery  of  new  ore 
bodies,  etc.,  the  property  increased  in  yalue  until  in  1910 
after  an  appraisal  it  was  entered  on  the  books  at  $10,- 
000,000  and  the  surplus  was  increased  accordingly.  In 
1917  another  appraisal  was  had  and  the  value  of  the  prop- 
erty was  then  fixed  at  $15,000,000.  The  balance  sheet  of 
the  corporation  now  shows  capital  stock  of  $1,000,000  and 
a  surplus  of  $20,000,000,  of  which  $14,000,000  is  repre- 
sented by  the  appreciation  in  value  above  described.  May 
the  appraised  value  of  the  property  be  taken  as  the  basis 
for  computing  invested  capital? 

Xo.  The  excess-profits  tax  law  expressly  places  the  computation 
of  invested  capital  upon  the  basis  of  the  cash  and  other  property 
actually  put  into  the  business,  plus  the  earned  surplus  and  undivided 
profits,  and  not  upon  that  of  a  present  valuation  or  appraisal  of  its 
assets.  Eeturns  in  which  the  invested  capital  includes  surplus  or 
undivided  profits  computed  upon  present  values  as  determined  by  an 
appraisal  can  not  be  accepted. 

36.  In  1907  a  corporation  acquired  a  manufacturing  plant 
valued  at  $500,000,  issuing  therefor  $500,000  of  capital 
stock.  The  books  of  the  corporation  on  December  31,  1916, 
showed  a  surplus  of  $1,000,000,  accumulated  through  the 
earnings  of  the  business.  Most  of  this  surplus  was  in- 
vested in  increased  plant  equipment,  etc.  In  December, 
1917,  the  property  was  appraised  (as  of  Jan.  1,  1917)  by 
an  appraisal  company  and  the  value  fixed  at  $2,500,000, 
or  $1,000,000  more  than  the  values  previously  shown  on 
the  books.  This  increase  was  attributable  mainly  to  in- 
creased value  of  land  and  in  part  to  larger  values  placed  by 
the  appraisal  company  upon  the  machinery  and  equipment. 
May  this  appreciation  of  $1,000,000  be  regarded  as  an 
earned  surplus  and  the  value  fixed  by  the  appraisal  com- 
pany in  December,  1917,  be  taken  as  a  basis  for  computing 
invested  capital  for  that  year? 

Xo.  The  same  rule  applies  here  as  in  the  case  stated  in  question 
No.  35.  For  the  purposes  of  the  excess  profits  lax  law  appreciation 
in  the  value  of  property  will  nol  be  regarded  a-  earned  surplus, 
and  an  appraisal  of  property  upon  cnrrenl  values  will  not  be  ac- 
cepted a-  a  basis  £or  computing  invested  capital. 

37.  A  proprietary  medicine  company  has  spent  large  sums 
in  advertising  and  has  thereby  built  up  a  good  will.  May 
these  sums  be  included  as  expenditures  for  a  capital  asset? 


14  EXCESS   PROFITS   TAX   PRIMER. 

If  the  money  was  spent  from  original  capital  the  original  capital 
is  of  course  allowed.  But  if  these  advertising  bills  were  paid  from 
income  and  the  amounts  charged  to  general  expense  they  can  not 
be  included  as  capital.  Good  will  can  be  included  only  when  bought 
and  paid   for  specifically  as  such. 

RETURNS. 

38.  A  corporation  is  engaged  in  the  brokerage  business, 
employing  only  a  nominal  capital.  According  to  article  73 
of  the  regulations,  it  is  taxable  at  the  8  per  cent  rate  under 
section  209  of  the  law.  Its  income  tax  return  is  made  out  on 
Form  1031.  Must  it  also  make  out  a  return  on  Form  1103, 
which  apparently  relates  only  to  corporations  having  an  in- 
vested capital? 

Yes.  Every  corporation  claiming  to  have  only  a  nominal  capital 
must  file  a  return  on  Form  1103.  however  small  its  capitalization 
may  be. 

39.  If  a  corporation  claiming  to  have  only  a  nominal  capi- 
tal files  a  return  on  Form  1103,  will  this  not  be  construed  as 
an  admission  that  it  has  invested  capital  and  is  taxable  at  the 
graduated  rates  under  section  201? 

No.  This  return  is  required  for  the  sake  of  information,  so  as  to 
enable  the  department  to  determine  the  justice  of  the  claim.  The 
two  forms  (1031  and  1103)  should  be  filed  together  and  should  bo 
accompanied  by  a  statement  describing  the  nature  of  the  business, 
the  purposes  for  which  the  capital  is  employed,  and  any  other  facts 
tending  to  show  that  the  corporation  is  of  a  kind  properly  taxable 
under  section  209,  at  the  8  per  cent  rate. 

40.  In  the  case  of  a  corporation  claiming  to  have  only  a 
nominal  capital,  on  which  form  and  under  what  schedule 
should  the  tax  at  the  8  per  cent  rate  be  computed? 

(a)  In  the  case  of  a  domestic  corporation,  take  the  net  income 
as  shown  in  item  6,  Schedule  I  of  Form  1103,  compute  8  per  cent 
on  the  amount  thereof  in  excess  of  $3,000,  and  enter  the  result  as 
item  12  on  Form  1031.  (b)  In  the  case  of  a  foreign  corporation, 
if  the  net  income  shown  in  item  6,  Schedule  I  of  Form  1103  is  in 
excess  of  $3,000  the  tax  will  be  8  per  cent  upon  the  whole  amount 
and  should  be  entered  as  item  12  on  Form  1031.  (c)  In  either  case 
it  should  be  noted  under  item  12  that  the  tax  is  computed  at  the 
8  per  cent  rate. 

41.  If  a  corporation  during  1917  made  less  than  7  per  cent 
on  its  invested  capital,  is  it  required  to  file  an  excess-profits 
return? 

Every  corporation  having  an  income  for  the  taxable  year  of  $3,000 
or  over  is  required  to  file  an  excess-profits  return,  even  though  its 
total  deduction  may  be  in  excess  of  its  net  income. 

42.  On  Form  1065  (partnership-income  return)  it  is  stated 
on  page  1,  under  "  5.  Excess  Profits  Tax,"  that  "  If  the  part- 
nership reports  any  income  from  sources  other  than  those 
included  under  A,  page  3,  it  must  make  a  return  and  compute 
the  amount  of  tax  (if  any)  on  Form  1102."  If  a  domestic 
partnership  rendering  professional  or  personal  services  and 


EXCESS  PROFITS  TAX  PRIMER.  15 

reporting  its  main  income  in  block  A  also  reports  a  small 
amount  of  interest  from  bank  balances,  etc.,  in  block  F,  will 
it  be  required  to  make  a  return  on  Form  1102? 

No.  The  income  of  a  partnership  or  corporation  (unlike  that  of 
an  individual)  must  be  taxed  as  a  unit — all  under  the  graduated  rates 
or  all  at  8  per  cent.  (See  art.  14  of  Regulations  Xo.  41.)  If 
the  partnership  has  a  substantial  amount  of  capital  (however  in- 
vested), return  must  be  made  on  Form  1102  for  purposes  of  informa- 
tion. (See  answers  38  and  39  above.)  But  if  the  partnership  has 
only  a  small  capital  and  is  clearly  taxable  at  the  8  per  cent  rate  as  to 
the  income  from  its  principal  trade  or  business,  any  income  which  it 
derives  from  other  sources  will  be  taxed  in  the  same  manner  and 
there  will  be  no  occasion  for  a  return  of  invested  capital. 

43.  In  the  case  stated  in  question  No.  42,  how  should  the 
tax  be  computed? 

In  every  case  the  excess-profits  tax  of  a  partnership  is  to  be  com- 
puted upon  the  net  income,  as  shown  in  block  G,  page  4,  of  Form 
1065.  In  the  case  above  stated  this  will  consist  of  the  sum  of  the 
totals  reported  under  A  and  F.  The  tax  will  be  8  per  cent  upon  the 
amount  by  which  this  sum  exceeds  $G,000.  (The  statement  on  page  4 
of  Form  1065  that  the  excess-profits  tax  on  a  business  with  no  in- 
vested capital,  or  only  a  nominal  capital,  will  be  "  8  per  cent  of  the 
amount  by  which  the  net  total  reported  under  A,  page  3,  exceeds 
$6,000,  or  in  the  case  of  a  foreign  partnership,  8  per  cent  of  the  entire 
net  total  reported  under  A"  applies  only  in  cases  where  the  entire 
net  income  falls  in  block  A.) 

44.  Will  every  partnership  reporting1  income  from  busi- 
ness under  block  B,  page  3  of  Form  1065,  be  taxable  at  the 
graduated  rates  under  section  201? 

Not  necessarily.  Every  partnership  reporting  income  under  block 
B  must  make  a  return  on  Form  1102.  But  if  it  is  clear  that  its 
principal  trade  or  business  consists  in  rendering  personal  service 
(income  reported  under  block  A)  and  is  taxable  at  the  8  per  cent 
rate,  all  ot  i(s  income  will  be  taxed  at  that  rate  even  though  a  part 
of  it  may  be  derived  from  "  invested  capital." 

45.  Block  C,  on  page  3  of  Form  1065,  provides  space  for 
entering'  profits  from  sale  of  real  estate,  stocks,  bonds,  and 
other  property.  If  a  partnership  sustains  a  net  loss  from 
such  transactions  can  it  take  account  of  such  loss  in  com- 
puting its  net  income  subject  to  the  excess-profits  tax? 

Yes.  The  loss  should  be  entered  in  red  ink  or  as  a  negative  quan- 
tity in  block  C. 

46.  On  the  individual  excess-profits  tax  return  (Form 
1101)  there  appears  under  schedule  B  a  column  for  enter- 
ing the  "  Cost  "  of  assets  acquired  except  "  tangible  prop- 
erty put  into  the  business."  Where  should  the  value  of 
tangible  property  put  into  the  business  be  entered? 

In  the  same  column  (column  '2.  headed  "Cost").  If  (he  property 
was  put  in  before  January  1.  !•>! !.  enter  the  value  as  of  thai  date; 
if  put  in  on  or  after  that  date,  enter  the  value  as  of  the  time  when 
put  in.  In  all  such  cases  enter  along  with  the  description  of  the 
asset  the  date  when  it  was  paid  in. 


If)  EXCESS    PROFITS   TAX    PRIMER. 

47.  If  an  individual  who  keeps  books  reports  his  invested 
capital  in  schedule  A  on  Form  1101,  must  he  also  fill  out 
schedule  B? 

Xot  necessarily,  [f  invested  capital  is  reported  in  schedule  A,  the 
return  should  be  accompanied  by  a  statement  explaining  adjust- 
ments. In  many  eases,  however,  it  may  be  advisable  to  fill  in  the 
-paces  provided  in  schedule  B  for  the  description  of  assets  and  their 
proper  valuation.  This  may  lie  useful  in  connection  with  the  ex- 
planatory statement. 

48.  Item  7  in  schedule  A  of  Form  1101  (individual  excess- 
profits  tax  return)  calls  for  the  excess  of  inadmissible  assets 
over  liabilities.  Should  an  individual  reporting  his  invested 
capital  in  schedule  A  specify  the  amount  of  liabilities  and  in- 
admissible assets  respectively  under  items  23  to  27  of 
schedule  B? 

Yes.  Tins  is  the  most  convenient  way  of  explaining  item  7  of 
schedule  A. 

49.  How  does  a  member  of  a  partnership,  in  making  his 
individual  income-tax  return,  report  his  credit  for  his  propor- 
tionate share  of  the  excess-profits  tax  assessed  against  the 
partnership?  Does  he  add  that  share  to  any  excess-profits 
tax  assessed  against  him  as  an  individual  and  report  this  sum 
in  block  L  on  Form  1040? 

Xo.  On  Form  10G5.  page  4,  the  partnership  takes  credit  for  its 
excess-profits  tax  (block  J)  before  arriving  at  the  net  income  to  be 
shared  by  the  partners  ( block  K) .  So  the  individual  partner  in  report- 
ing his  total  net  income  (Form  1040,  block  K)  has  already  deducted 
his  proportionate  share  of  the  partnership  excess-profits  tax  and  he 
may  not  again  include  that  share  as  a  part  of  his  deduction  under 
block  L  oi'  Form  1040.  He  should  enter  in  that  space  only  the  amount 
of  excess-profits  tax,  if  any.  assessed  against  his  as  an  individual. 

50.  On  page  2  of  Form  1065  (partnership-income  return), 
under  the  heading  "  Other  expenses  "  is  the  following  in- 
struction: "  Do  not  deduct  salary  for  any  partner's  services 
unless  such  salary  is  paid  in  accordance  with  a  prior  agree- 
ment properly  recorded  on  the  books  of  the  partnership." 
Does  this  instruction  supersede  article  32  of  the  regulations? 

Xo.  With  respect  to  any  period  prior  to  March  1,  1918,  a  salary 
deduction  for  services  actually  rendered  will  be  allowed  regardless 
of  whether  a  previous  agreement  had  been  made. 

51.  A  corporation  in  which  most  of  the  stock  is  owned  by 
its  officers  has  in  the  past  voted  to  its  officers  only  nominal 
salaries  as  drawing  accounts.  In  computing  net  income  for 
purposes  of  the  excess-profits  tax  may  the  corporation  deduct 
as  items  of  expense  amounts  which  would  constitute  reason- 
able compensation  for  the  services  actually  rendered  by  its 
officers? 

res,  if  a  satisfactory  explanation  is  given.  For  any  period  prior 
i,i  March  !.  1918,  reasonable  salaries  for  services  actually  rendered 
may  be  deducted  even  though  the  full  amounts  had  not  been  formally 
voted  as  salaries  by  the  corporation. 

LAW  LIBRARY 

UNIVERSITY  OF  GALEFGRNIA 

LOS  ANGBLES 


GAYLAMOUNT 
PAMPHLET  BINDER 

Manufactured  by 

GA/LORD  BROS.  Inc. 

Syracuse,  N.Y. 

Stockton  Calif. 


IllSl/riii!?!^1?^1  lib«arv  FACLiry 


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